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There is an expression - "Too big to fall." - which means that if a bank or a financial institution manages a sufficient part of the financial assets than the state can't afford that this bank or institution goes to fall, because it causes a big shock in the market, and can break the economic system of a country.

So the question arises: why did american state not save the Lehman Brothers and AIG? Because if these banks didn't fail, the crisis wouldn't have started.

An other question: How can the Rating Institutions has given 'AAA' rating for extremely risk assets (like CDO and CDS)? Nobody realized that (where work a lot of profession workers) if the debaters can't pay back their very risk loans it can be broke the whole system?

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  • $\begingroup$ There is a separate theory which basically says Lehman was one of Goldman's biggest competitor in fixed income. And because of revolving door between industry and regulators, lot of senior GS people worked (and still work) as regulators (eg. Rubin, Geithner, Kashkari, Paulson, Shafran etc.). You do the math. $\endgroup$ – InnocentR Apr 1 '16 at 13:15
  • $\begingroup$ cont ... AIG was saved because GS had massive exposure to it and AIG bankruptcy would have cost GS a lot of money. Data is publicly available to back this up. $\endgroup$ – InnocentR Apr 1 '16 at 13:17
  • $\begingroup$ Ex Post its easy to prevent anything. $\endgroup$ – user9403 Apr 4 '16 at 19:03
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U.S. Government DID save American International Group (AIG) from bankruptcy, since it was considered too big to fail, actually: a lot of financial institutions were insured by AIG. This Investopedia page is a nice summary on the topic about AIG's bailout. Here (Investopedia again) about Lehman Brothers, that became really too much leveraged and exposed to the subprime business.

Personally, I think that it ALL begun with the deregulation driven by the FED and its chairman Alan Greenspan (Wiki) during the '90s and earlier '00s, who was too much confident about the self-correcting capacity of the markets.

The rating agencies are paid from financial institutions (for example) to give a rating to the firm, the products sold, etc. During the decade before the financial crisis, there were very too much money involved into the business, and it was convenient for everyone to give the highest rating possible also to very bad products, since this led other money in the pockets of financial institutions, without thinking to the consequences. The leaders of that companies are, in any case, safe from the losses: they got millions (even dozens of millions) in "severance pay" after the collapse of the financial markets.

EDIT: Probably, sooner or later, the crisis would have started even with the bailout of Lehman Brothers, since the situation was very unsustainable (not only for the questioned bank): you can read in this NY Times article the proportion of the help that U.S. Government gave to both the biggest banks and minor financial institutions. The literature about the topic is very wide and you can find a lot of data (losses, debts, magnitude of subprime mortgages and related derivatives products that financial institutions all over the world bought) and explanations (conspirancy theories appear very plausible to this situation, such as the one explained by @InnocentR on the comments).

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Regarding how the rating agencies gave AAA ratings to CDOs and the like that clearly did not deserve those ratings - straightforward answer. The SEC licences all the ratings agencies as "nationally recognized statistical rating organizations" (NRSRO). It is blindingly obvious that the SEC was not actually overseeing the rating organizations that it was responsible for overseeing. It was a joke for years about the crap loans that were being loaded into the CDOs and other asset backed securities - the "NINJA" mortgages (no income, no job). Despite the flurry of commentary in the markets and in the media, the practices of loading junk mortgages into CDOs and the ratings agencies rating this crap AAA continued. The head of the SEC from when the dot-com bubble burst until the beginning of the mortgage crisis is singularly responsible for the housing crisis. Banks will always take excessive risks just as kids will always reach for the cookie jar. Oversight is there for a reason and DID NOT HAPPEN. And the lack of accountability of the overseers is appalling. Regulation servers a purpose - IF IT IS ACTUALLY DONE.

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The crisis was mostly underway at least two years before Lehman's demise. Saving Lehman would not have been enough to stop the recession, housing market bust, and other problems.

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your 1st question. The GFC did not happen because Lehman was not rescued. Lehman failed because of the GFC. A financial crisis happens because some kind of mismatch accumulates or resp. economic misallocation happens (too much bubble growth).

your 2nd question. keywords: rating shopping, regulatory arbitrage.

i am going list some points that might be helpful:

  • Basel 1 to Basel 2 change. Banks started to calculate their regulatory capital depending on value at risk models. This triggered a race to the bottom, or resp. regulatory arbitrage, or resp. legal window dressing. (the same happens now with Solvency 2 for european insurance firms)
  • Supervisory models used, and are still using, ratings as input parameters. This is the core of CRAs' business model - it is the reason for the CRA industry total sales. (there are few new supervisory models without ratings but that are exceptions)
  • Ratings are positive biased because there is selection. Also called rating shopping. The debt issuer is the customer of a CRA. If a CRA grants a weak rating, the customer simply pulls off, and walks to another CRA. (the big CRAs are judging a little bit more conservative these days but the business model is still the same)
  • Central Bank policies. Before the GFC central bank belived they could control and countermeasure everything by interest rate policies. They simply did not monitored the whole money creation process which is mainly executed by the broader financial sector. You cannot worry about stuff you do not know (it is really funny because the big central banks are still in the process to establish data collection processes regarding debt issuance)
  • Politics. do not forget that the U.S. spend a lot of fiscal (and human) ressources on two wars during the 2000s (and their NATO partners did the same on a smaller scale). Good economic growth, increasing living standards, more ownership, more ... distraction ... makes a population happy. Agency ABS are government programs that were heavily pushed by the Bush government to create a lot happiness.
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